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A growing number of experts say a slavish devotion to a 2-per-cent inflation rate may be harming the economy.Jan Stadelmyer/Getty Images/iStockphoto

The economic academy's thinking about monetary policy is turning heretical.

For two decades, central banking in the United States, Canada and the rest of the world's advanced economies has been rooted in the simple notion that policy should target an annual inflation rate of 2 per cent.

There always were murmurs of discontent. But lately, with the global economy drifting toward what some fear could be a recession, the criticism of central bankers' devotion to slow inflation is turning into something more substantial.

The U.S. Federal Reserve, the Bank of Japan and the European Central Bank have dropped official borrowing rates to record low levels and they have spent hundreds of billions buying bonds and other assets – yet economic growth continues to languish.

Part of the problem could be the inflation targets, according to a growing collection of economists, including a surprising number of the profession's high priests.

Because of the surge in commodity prices earlier this year, inflation in many advanced economies is running up against central banks' targets, even though consumer spending is weak and unemployment is high. By sending a signal that they would be willing to accept inflation hotter than 2 per cent, policy makers could potentially stir more investment and hiring. That's because some executives and investors likely are holding back out of fear an inflation-obsessed central bank could suddenly raise the cost of borrowing.

"Sometimes it would be good to have a higher inflation rate," Peter Diamond, the Massachusetts Institute of Technology professor who shared the 2010 Nobel Prize in economics, said in an interview. "If the Fed would cause 4-per-cent inflation, I would vote for it immediately."

If not for talk like that, Prof. Diamond might actually have a vote on the Fed's policy making committee.

President Barack Obama nominated him for a vacancy at the Fed, but Richard Shelby, the top Republican on the Senate banking committee, refused to clear the way for the Nobel laureate. One of Mr. Shelby's stated objections was a worry that Mr. Obama's nominee would be too soft on inflation. Prof. Diamond withdrew from consideration for the Fed in June.

Many said Mr. Shelby was more intent on embarrassing the White House than making a stand against inflation. Even if that's true, the fact Mr. Shelby would invoke inflation to achieve his political ends shows just how entrenched is the idea of keeping price increases to an absolute minimum.

In February of 2010, Olivier Blanchard, the chief economist at the International Monetary Fund, published a paper that suggested central banks should aim for an annual inflation rate of 4 per cent. With benchmark rates at zero, Mr. Blanchard argued that the financial crisis showed that central banks' tolerance for price increases was too severe. Had inflation been allowed to run faster, policy makers might not have found themselves up against the "zero bound," the IMF economist said.

Mr. Blanchard was widely ridiculed, especially by central bankers. "He got hammered," said Vincent Reinhart, resident scholar at the Washington-based American Enterprise Institute.

But suddenly Mr. Blanchard has company.

At a conference last week in Lindau, Germany, Roger Myerson, who shared the Nobel Prize in economics in 2007, joined Prof. Diamond in arguing for a more flexible approach to inflation.

Kenneth Rogoff, the Harvard University professor and former IMF chief economist, repeated last month that a "sustained burst of moderate inflation" might be the most practical way to ease the debt burdens that are weighing on the economies of the U.S. and Europe.

Two weeks ago, Charles Evans, the president of the Chicago Fed and a voter on the Fed's policy committee, told CNBC in an interview that he favoured allowing medium-term inflation to increase to more than 3 per cent to help lower the unemployment rate.

Mr. Evans's remark shows the debate about strict inflation targets is more than faculty club thrust and parry.

The Bank of Canada for several years has been studying the efficacy of a strategy called "price-level targeting," which would see policy makers attempt to achieve a certain increase in nominal prices, rather than tie policy to achieving an annual inflation rate of between 1 per cent and 3 per cent. Such a strategy would allow the central bank to accept a faster pace of price increases when the economy was weak. Canada's central bank and the Finance Department are set to decide whether to adopt price-level targeting by the end of the year.

Of course, the Bank of Canada also is considering whether to reduce its inflation target to 1 per cent. Central banks still are traumatized by what it took to choke double-digit inflation in the 1970s. It took those institutions years to convince consumers, executives and investors that policy makers would do whatever it took to contain inflation. It will take a lot to convince central banks to risk that credibility to embracing higher inflation targets.

"The risk you run is you confuse the public about your intentions," said Mr. Reinhart, a former director of the Fed's monetary affairs division. "If inflation gets higher than you want, it can be costly to bring it down."

Rather than reconfigure their policy mandates, central banks may instead cash in some of their hard-won credibility.

The Bank of England, for example, is holding its benchmark lending rate at a record-low 0.5 per cent even though inflation is more than double its target. And the Fed last month made a conditional commitment to leave its key rate near zero until mid-2013, even though prices pressures are building.

"An inflation target right now isn't preventing anyone from monetary stimulus," said Christopher Ragan, an economics professor at McGill University in Montreal and a former adviser at the Bank of Canada. "In Canada and the U.S., you have central banks that have it wide open. I don't think they are worried about inflation."

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